How to Increase the Profitability of a Professional Services Firm?

Principle 3: Understanding Profit Levers  

As owners or partners (depending on the type of professional service company) we are sellers, managers, administrators, key content experts, marketers. Wearing different hats is hard and challenging. We have a strong temptation to do the daily client work, as it is of the best quality (obviously), and fortitudes a good relationship with the client. 

However, if you look at that from a pure money perspective, it doesn’t work this way. You should be minimizing the hourly input of more expensive employees, including owners, key directors, experts, and managers. 

Usually, these people have limited capacity. Sometimes they can allocate 50%, sometimes less of their time for the client’s work. They need to bring new business, manage relations, solve problems – you know, generally do unbillable stuff.  

However, to serve the client well, they need 10h per client a month and bill them at $250 hourly rate. It means their overall revenue capacity is at $20,000/month per employee if we assume working half-time for clients and having 8 relationships within 160h working month. These people are expensive, earning $100/hour, so their overall profitability leaves us at $4,000 – a 20% gross margin.  

And now that’s the maximum we can do, they simply can’t produce more work. Now, we know that middle specialist can work with this client at substantially lower rate of $150 hourly rate, need similar 10h per client, but require 2h of senior support additionally to check their work and help with problem solving.  

However, they can work at 80% billability as this is their main job focus – this is a critical lever to pull. They can bring ~13 different relationships a month: $19,500 revenue/month from this specialist. Keep in mind, we have also had $500 on top from senior hours – the overall deal size for our client remains the same.  

Assuming they earn an average of $50 per hour for a person at middle seniority, you get $13,000 margin from the client work.  

What happens here is we have pushed the work to less experienced employees and unlocking the capacity of senior people to bring more work. Now, they can handle up to 40 clients a month, so a hiring decision is clear. 

This example lies on the basic foundations of rate cards and hourly cost structure, you can put your own numbers to see how it works.  

At Valueships, we use a simple ratio of senior hours consumed on a project vs. overall hours. For us, this benchmark is at about 10%, but probably you will have your own. 

Book: Martin van der Mandale, Henk W. Wolberda, Rob B. Wagenaar: “The New Professional Service Firm: How Consultants, Accountants, and Lawyers Need to Reinvent Themselves”   

Principle 4: Everything is a factory. 

In production and manufacturing, there is a concept of Overall Equipment Effectiveness (OEE). Overall equipment effectiveness is a measure of how well a manufacturing operation is utilized compared to its full potential during the periods when it is scheduled to run. It identifies the percentage of manufacturing time that is truly productive. 

What is a productive time in a professional services company? Obviously, time spent on the client, a.k.a. utilization, a.k.a. billability, a.k.a. chargeability. No matter how you call it, it’s effectively: 

Time spent on the clients / Total time spent working. 

According to Maciej Prokop, our Consultant who did a lot of work on billability and utilization projects:   

“What is a good ratio? Depending on the business, an average for professional services is at ~70%, while a good operating benchmark is at about 80%. "

Effectively, the more time we spend on clients, the more money we can get. No matter what your role is. Adding the profitability level of moving senior work to more junior people, while maintaining quality, you’re building a strong margin structure. 

Now, let’s look at the simplified profit & loss statement of a company: 

You have a team of 4 senior people, 8 middle, and 20 juniors. Their overall utilization at various levels brings 17% of net profit margin.  

See what happens if you increase your utilization by 5%: 

You have increased profits by 3 p.p. Now, let’s compare the same baseline scenario to increasing the workforce by 25% (it’s a lot!): 

Your profit margins didn’t move at all. While your overall profit in absolute numbers grew substantially, your lever didn’t pull the company forward. 

The basic idea here is how to maximize workforce output without making them overworked or hurting the organizational culture. You need to be ruthless when it comes to wasting time. Cancel the unproductive meetings, reduce average meeting size, try playing with asynchronous work, ensure effectiveness at all levels, including meeting notes, clear agendas, etc. You can even go full extreme and show how much it costs. As they say: in many organizations a junior person can’t expense a $100 lunch bill but can organize a $1500 meeting with senior people.  

However, it won’t happen if you don’t track and measure it on the right levels. First, you need to have time tracking software (case Timecamp podlinkowac) and the right timesheet process. A good one allows users to track time smoothly without taking more of their productivity. There are numerous hacks for doing so, but you need to have an organizational habit. Thanks to that, you will become leaner in your day-to-day processes.  

When to expect initial results? According to Aleksandra Kawa, our Operations Manager: 

“On average, it takes 6 to 12 months to get initial insights from time tracking, so leadership needs to be involved and promote this activity in the organization. In the end, the example comes from the above. In Valueships case, we have implemented one tool that didn’t adopt, tried another, which worked. It took us a year and a half before we came to the good operating model. Frankly, it’s a painful process, but achieving a good sense of control and business understanding rewards the effort. 

Book recommended: Andy Grove, “High Output Management.”   

Principle 5: Price to value. 

Obviously, as a consulting company mostly focused on pricing, we must recommend pricing as the strongest profitability level. In general, the research proves that 1% of price increase leads to 8-12% of profitability ratio increase. 

But let’s use our favorite P&L example: 

The impact of price increase gets almost immediate, resulting in similar impact as improved utilization. 

Obviously, easier said than done, so you need to increase the value of your services. So how to get this done? 

There are many ways, and probably require another post for that, but to give you few very operational hints that allow you to tweak prices and get closer to value selling: 

• Bill for value – if something took 40h, and now it takes 10h to produce, but you have learned it, then it’s fine to charge more. 
• Play with different value metrics – have you considered doing a fixed-bid for some projects instead of time & material hourly rate? How about putting some things into blended rates or ensuring that part of your work is based on a 2-part tariff (base + variable) 
• Push for value-added services (VAS) you can add to your mix – customers love priority support, skip the line, SLAs, etc. 
• Consider presenting the initial ROI from your services, and always show value to generate and your prices – anchoring makes wonders. 

Book: Paul Reilly, Tom Reilly, Value-Added Selling, Fourth Edition: How to Sell More Profitably, Confidently, and Professionally by Competing on Value-Not Price” 

Summary: 5 tactics you can use to boost your profitability 

The principles help me and Kris manage day-to-day Valueships operations and grow our practice 80% year-to-year. Keep in mind that principles are the general rules to follow, but you can build your own. Effectively, while every services firm is following a somewhat similar mission of:  

“To deliver outstanding client service; to provide fulfilling careers and professional satisfaction for our people; and to achieve financial success so that we can reward ourselves and grow.”  

I totally believe that the devil lies in the details, so use them as you wish. For instance, I know founders focused on extreme automation of repeating processes or the ones that are purely focused on building a conglomerate of linked services (value-added), which operate from one cost center.  

For us, we help with profitability, cash flow, and to conclude let’s not reinvent the wheel.  

What are the profitability tactics for professional services firms? A quote D. Maister from his outstanding: “Managing Professional Services Firm” book and add few things on our own. 

1. Raise prices

• Increase prices to existing customers, especially the ones with recurring or maintenance work (the likelihood of them leaving is low) 
• Add COLA (Cost of Living Adjustment) to your agreements and deals, so you can regularly increase fees (inflation adjustments) 

• Earn higher fees through specialization, innovation, adding more value (e.g., more specialized consulting) 
• Target high profile customers to get “better work” (basically, try getting different type of customer) 
• Speed up skill building process in staff (trainings, getting them to own the staff) 
• Invest in new (higher value) services (software, analytics, VAS) 
   

2. Lower variable costs

• Improve engagement management performance (project management is critical) 
• Increase leverage in the delivery services (user more juniors vs. seniors) 
• Make greater use of paraprofessionals (put some slack on overhead staff) 
• Develop methodologies to avoid duplication of effort (codify knowledge ruthlessly) 
   

3. Fix underperfromers

• Deal with underperformers (don’t get overly attached) 
• Drop unprofitable services (some things you do are not that great, deal with it) 
• Drop unprofitable clients (it’s fine to let go some of them) 
   

4. Increase volume

• Increase utilization (billable hours per person) 

• Play with fixed bids and value-based selling where you think you can win on margins (projects with codified knowledge, solid processes) 
   

5. Lower overhead costs 

• Improve speed of billing (send invoices faster or bill some part up front) 
• Improve speed of payments (you don’t need 14 days on the invoice) 
• Reduce space and equipment cost (your office can be smaller) 

• Reduce support staff costs (usually use them only for senior staff members) 
• Reduce nonbillable workforce (for every unbillable person, you need 5 others to pick up client work) 
• Automate processes with SaaS tools (billing, invoicing, tools)
  

FAQ Section

1. What are the core principles of general and industrial management as proposed by Henri Fayol, and how do they apply to modern management?

Henri Fayol, a pioneer in the field of general and industrial management, proposed 14 core principles that serve as foundational guidelines for managing organizations. These principles include division of work, authority and responsibility, discipline, unity of command, unity of direction, subordination of individual interests to the general interest, remuneration, centralization, scalar chain, order, equity, stability of tenure of personnel, initiative, and esprit de corps. In modern management, these principles are still relevant as they provide a framework for organizational structure, promote efficiency, encourage teamwork, and guide managerial actions to align with organizational goals. They have been adapted to fit contemporary business environments, emphasizing flexibility, employee engagement, and a more participative approach to leadership.

2. How does operational planning contribute to achieving organizational goals, and what role does a successful manager play in this process?

Operational planning is a critical component of achieving organizational goals as it involves outlining specific actions, resources, and timelines needed to execute the strategic plan at an operational level. It translates broad strategies into day-to-day tasks, ensuring that the organization moves cohesively towards its objectives. A successful manager plays a pivotal role in this process by clearly communicating the plan, coordinating resources, monitoring progress, and making adjustments as necessary to address challenges and opportunities. The manager ensures that the team's efforts are aligned with the operational plan and ultimately contribute to the organization's success.

3. How do modern management theories integrate technical skills and managerial responsibility to maximize efficiency within an organization?

Modern management theories recognize the importance of integrating technical skills and managerial responsibility to maximize organizational efficiency. Technical skills are necessary for understanding and executing specific tasks, while managerial responsibility involves planning, organizing, leading, and controlling resources to achieve organizational goals. Modern theories advocate for a balanced approach where managers not only possess the technical expertise relevant to their field but also strong leadership and strategic thinking abilities. This integration ensures that managers can effectively guide their teams, make informed decisions, and implement processes that enhance productivity and efficiency.

4. In what ways can management ensure job security and align individual interests with organizational goals?

Management can ensure job security and align individual interests with organizational goals by creating a positive work environment that values employee contributions, offers opportunities for professional growth, and provides clear communication about organizational objectives. Implementing fair and transparent performance evaluation systems, providing competitive compensation, and encouraging employee participation in decision-making processes can also promote job security and alignment of interests. By actively engaging employees in setting goals and recognizing their achievements, management can foster a sense of ownership and commitment, ensuring that individual efforts contribute to the broader organizational success.

5. What challenges might arise from having more than one manager with the same objective, and how can great management overcome these challenges to avoid confusion?

Having more than one manager with the same objective can lead to confusion, duplication of efforts, and conflicts due to overlapping authority and unclear responsibilities. To overcome these challenges, great management practices involve clearly defining roles and responsibilities, establishing effective communication channels, and setting up coordination mechanisms to ensure managers work collaboratively towards the common objective. Implementing Henri Fayol's principle of unity of command, where each employee reports to only one manager, can also help minimize confusion. Additionally, fostering a culture of teamwork and mutual respect among managers can facilitate problem-solving and decision-making, ensuring that efforts are synergized rather than fragmented.

‍

‍